New Oil Price Driver

Jim Brown
 
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The Middle East has been a driver of oil prices for the last two months but now we have a new force pushing prices higher. The economic news is suddenly improving and demand expectations are growing.

A recent flurry of better than expected economics is making it more likely the Fed will begin to taper QE but those same economic reports also suggest the global economy is finally finding some traction. A return to a strong growth path in the U.S. and Europe would also energize Asia and that could quickly boost demand over the next two years by 2.0 mbpd and the amount lost during the recession. If the economics continue to get significantly better this could be a game changer.

The ISM Manufacturing report for August showed a minor gain from 55.4 to 55.7 but the consensus was for a decline to 53.3 so the report was significantly better. However, the U.S. is no longer a manufacturing economy. It has become a services economy after all the manufacturing was shifted to Asia and Mexico.

The ISM Nonmanufacturing otherwise known as the ISM Services spiked from 56.0 to 58.6 in August compared to estimates for a decline to 53.7. This was the equivalent of a blowout in economic terms with the headline number hitting the highest point since 2005. New orders moved to 60.5 for the first print over 60 since February 2011. Employment spiked from 53.2 to 57.0 and the highest level for 2013.

The ADP Employment report declined from +200,000 jobs in July to a gain of +176,402 in August. Given the strong employment component in the ISM and the decent ADP report the consensus estimates for Friday's Nonfarm Payroll report may be too low. The consensus estimate is for a gain of +185,000 jobs. Anything over +175,000 is likely to force the Fed to begin tapering QE at the September meeting.

While the market may react negatively to a QE reduction on better economics the long term market outlook is getting better. A stronger global economy means stronger earnings and a stronger market. It may take the market a while to shake off the QE addiction but as long as the economic numbers continue to improve the short term volatility will be worth it.

Oil Inventories

The oil inventories from the EIA were delayed one day because of the holiday. I delayed the Wednesday newsletter until the inventories were released.

The EIA said oil and gasoline inventories both declined more than expected for the week before the holiday. Crude oil declined -1.8 million barrels to 360.2 million thanks to an increase in demand by refineries of +162,000 bpd and a drop in imports of -119,000 bpd. U.S. crude production rose to another 18-year high at 7.621 mbpd.

Crude Inventory Chart

There is a real story underway at Cushing Oklahoma, the delivery point for WTI futures. Inventories fell nearly -2 million barrels from 36.6 to 34.8 million. That is the seventh consecutive weekly decline and well off the historic high of 51.1 million in April. This is due to more oil being shipped directly from fields to refiners by rail and more takeaway capacity from Cushing. Also, with Brent prices, prior to the Middle East spike, only slightly higher than WTI it makes sense for refiners to buy from the pipelines rather than the hassle and uncertainty of importing. They never know when a new flare up of violence will suddenly cut off their supply from the Middle East. The hurricane season also adds uncertainty until we get into October. September 11th is the normal peak of the storm season.

Gasoline Inventories declined -1.8 million barrels as retailers stocked up for the Labor Day weekend. We should see gasoline inventories uptick slightly over the next couple of weeks then begin their slow decline into the changeover period for winter blends. Production declined -338,000 bpd and imports fell -240,000 bpd. That should have produced an even bigger decline in inventories so I would expect to see a sharper decline next week.

Gasoline Inventory Chart

Distillate inventories rose by +500,000 barrels thanks to an increase in production of +161,000 bpd. You can thank diesel and heating oil for the increases. Truck traffic will increase as we head into the holiday season. Stores will be stocking up for the Nov/Dec shopping seasons. This will increase diesel demand and the approaching colder weather will bring back demand for heating oil.

Distillate Inventory Chart

(Inventory Snapshot guide: Green squares are multiyear highs. Yellow is multiyear low. Orange is multi month high. Pink is multi-week highs. Blue is multi-week low. The number of active gas rigs at 350 is an 18 year low. Oil rigs at 1,412 is an eight-month high. Crude oil at 397.6 mb is the highest since 1931.)

Inventory Snapshot

Last week I wrote about the abnormal hurricane season and the lack of storms so far this year. Apparently Mother Nature was paying attention because there are suddenly an entire series of storms headed our way.

Already in the Gulf of Mexico is a storm system with a 50% chance of turning into a named storm. If it does become a storm it should not be a material problem because the track is towards a Mexican landfall.

Tropical storm 7 increased in intensity to become tropical storm Gabrielle and is located south of the Dominican Republic with sustained winds of 30 mph. Gabrielle is expected to move north over the DR and eventually east of Florida. There is another tropical depression north of the Leeward Islands with a 20% chance of becoming a material storm. However, it is too close to Gabrielle to become much of a threat. The two will probably merge and cancel each other out.

There is another depression forming about 500 miles from Cape Verde and headed in our direction. This storm has a low chance of gaining strength because of extremely dry air coming westward from Africa.


Syria has become even more belligerent saying "We are mobilizing our allies for retaliation and we will not change our position even if it leads to World War III." Meanwhile Russia moved three more ships into the Mediterranean bringing the total to 21. The three new ships were the SSV-201 intelligence ship Priazovye and two amphibious landing ships the Minsk and Novovherkassk. Last week Russia announced it was sending a guided missile cruiser and a large anti-submarine warfare vessel offshore Syria.

Putin is the host of the G20 meetings this week in Russia and there have been several awkward and or heated exchanges by participants over the Syria question. Putin said in an interview "Obama lies and everyone knows he lies and that is sad." Putin went so far as to forbid Syrian conversation until the dinner meeting late on Thursday.

Military planners said the initial strike on Syria is likely to cost more than $500 million and continued operations would cost about $1 billion a week. Currently the ships on station in the eastern Mediterranean cost $27 million a week just to operate. The Senate authorization for force is currently stated for 60 days. A month long operation would cost more than $5 billion and come out of a Defense Dept contingency fund.

If the Syrian supporters actually did retaliate against Israel, Lebanon, Jordan, Turkey, Iraq, Oman and Saud Arabia as they have warned the entire region could be drawn into a lengthy conflict and oil prices would go out of sight. Oil fields in Saudi Arabia, Oman and Iraq would be prime targets.

After a brief flurry of comments from senators and representatives supporting the use of force initiative there has been a lot of negative rebuttal. There are still more lawmakers either undecided or strongly against the measure than there are currently for the attack. If the measure fails next week when the vote is taken we can expect a much rougher debt ceiling debate and budget battle. The president will be looking for a pound of flesh from anyone that voted against his request.

Market

The Dow has traded in a narrow range for the last week between 14,750-14,950. End of month cash plus better than expected economics have kept the indexes from declining below last week's lows. However, we are just entering into the month of September and the headlines are not looking good. The Syrian distraction is currently replacing the debt ceiling, budget and FOMC QE decision but once past next week's Syrian vote it will be all Washington, all the time and it won't be pretty.


Jim Brown

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